Pakistan's Fiscal Challenge: Where the Money Goes and Why It's Never Enough

The Structural Nature of Pakistan's Fiscal Challenge

Pakistan faces a structural fiscal challenge, not a temporary shortfall. Between FY2015 and FY2024, the government ran an average deficit of approximately 6.4% of GDP.^[1] This persistent gap between spending and revenue has accumulated into a substantial debt burden that constrains policy options.

The fiscal deficit is the difference between what the government collects in revenue and what it spends. When expenditure exceeds revenue, the government must borrow the difference, adding to the stock of public debt.

The fiscal deficit reached 7.9% of GDP in FY2022, the largest in over two decades.^[1] While it has since narrowed to 6.8% of GDP in FY2024, the deficit remains roughly double the 3.5% ceiling mandated by Pakistan's Fiscal Responsibility and Debt Limitation Act (FRDLA).^[1]

Recent Fiscal Consolidation

FY2024 marked a turning point in Pakistan's recent fiscal history. The overall fiscal deficit narrowed from 7.8% of GDP in FY2023 to 6.8% of GDP in FY2024.^[1] More significantly, Pakistan achieved a primary surplus of 0.9% of GDP, its first since FY2007.^[1]

The primary balance excludes interest payments, showing whether the government's current policies generate enough revenue to cover non-interest spending. A primary surplus means the government is generating more revenue than it spends on programs and operations, though it still borrows to pay interest on existing debt.

Fiscal Year	Fiscal Balance (% GDP)	Primary Balance (% GDP)
FY2019	-7.9	-3.1
FY2020	-7.1	-1.6
FY2021	-6.1	-1.2
FY2022	-7.9	-3.1
FY2023	-7.8	-1.0
FY2024	-6.8	+0.9

Source: Ministry of Finance via World Bank PDU October 2024, Annex 3^[1]

This is a significant development. The overall deficit in FY2024 (6.8% of GDP) is entirely attributable to interest payments on the existing debt stock. If interest costs were lower, or if the debt stock were reduced, Pakistan could achieve fiscal balance.

Where the Money Goes: The Expenditure Side

Total government expenditure has ranged between 17.7% and 20.3% of GDP over the past decade, with FY2024 expenditure at 19.3% of GDP.^[1] The challenge is not that Pakistan spends excessively by international standards, but rather how that spending is allocated.

Interest Payments: The Growing Burden

The most striking trend in Pakistan's expenditure is the rising share consumed by interest payments. In FY2024, interest payments reached 7.7% of GDP, consuming 40% of total government expenditure.^[1] This represents a dramatic increase from FY2015, when interest payments were 4.3% of GDP and 24% of expenditure.^[1]

Fiscal Year	Interest Payments (% GDP)	Share of Total Expenditure
FY2015	4.3	24%
FY2018	3.8	20%
FY2022	4.8	24%
FY2023	6.8	35%
FY2024	7.7	40%

Source: Ministry of Finance via World Bank PDU October 2024, Annex 3. Share calculated as interest payments divided by total expenditure.^[1]

The jump in interest payments between FY2022 and FY2024 reflects the State Bank's monetary tightening cycle, which raised the policy rate from 13.8% at end-FY2022 to 22% by June 2023, and the subsequent rollover of government debt at higher rates.^[1]

Rigid Expenditure Structure

According to the World Bank's 2023 Public Expenditure Review, approximately 70% of federal spending is rigid, meaning it is pre-committed to interest payments, transfers to provinces, civil servant salaries, and pensions.^[3] This leaves limited fiscal space for discretionary spending, particularly development investments.

Development expenditure including net lending fell from 3.7% of GDP in FY2015 to just 2.0% of GDP in FY2024.^[1] The Public Sector Development Programme (PSDP) specifically declined from 3.2% of GDP in FY2015 to 1.9% of GDP in FY2024.^[1]

Development spending is typically the first casualty when fiscal pressures mount. When revenue falls short or interest costs rise, development projects are often delayed or cancelled to balance the budget in the short term. This underinvestment has consequences for long-term growth: infrastructure, education, and health investments that could raise productivity and expand the tax base are being crowded out by debt service obligations.

Subsidies and State-Owned Enterprises

Energy subsidies have historically been a major driver of fiscal pressures. According to World Bank estimates, cumulative subsidy spending between FY2013 and FY2022 was dominated by the electricity sector, accounting for approximately 80% of recurrent subsidies.^[4]

Federal state-owned enterprises (SOEs) have also been a persistent fiscal drain. The World Bank estimates that federal SOE losses have averaged approximately 0.5% of GDP annually since FY2016.^[4] The top 14 loss-making SOEs cost an estimated 0.8% of GDP annually (approximately PKR 458 billion).^[4]

Why Revenue Falls Short

The other side of Pakistan's fiscal equation is equally challenging. Total revenue (including grants) was 12.5% of GDP in FY2024, up from 11.5% in FY2023.^[1] However, this improvement came largely from non-tax revenue; tax revenue remained relatively flat at 10.5% of GDP.^[1]

A Stagnant Tax Base

Tax revenue as a share of GDP has remained remarkably stable despite Pakistan's economic growth. Over the past decade, tax-to-GDP has hovered between 9.9% and 11.4%, with no clear upward trend.^[1]

Fiscal Year	Tax Revenue (% GDP)
FY2015	9.9
FY2016	11.2
FY2017	11.2
FY2018	11.4
FY2019	10.2
FY2020	10.0
FY2021	10.3
FY2022	10.4
FY2023	10.1
FY2024	10.5

Source: Ministry of Finance via World Bank PDU October 2024, Annex 3^[1]

The World Bank estimates Pakistan's tax capacity at approximately 22% of GDP, suggesting roughly half of potential tax revenue goes uncollected.^[5]

Narrow Tax Base

Several structural factors contribute to Pakistan's low tax collection:

Limited Income Tax Coverage: According to World Bank estimates, fewer than 8 million people are registered for personal income taxes out of approximately 114 million employed.^[5] Direct taxes account for only about one-third of total tax collection; the rest comes from indirect taxes like sales tax and customs duties.^[5]

Agricultural Tax Exemptions: Agriculture contributes approximately 22-23% of GDP but generates minimal tax revenue due to provincial agricultural income tax thresholds.^[5] The World Bank estimates that over 90% of farmers fall below the 12.5-acre threshold for agricultural income tax.^[5]

Provincial Revenue Collection: Provincial governments collect less than 1% of GDP in own-source revenue, relying heavily on federal transfers.^[5] Property taxes, a provincial subject, are assessed at just 0.07% of capital value in Punjab, compared to approximately 0.5% in peer countries.^[5]

Tax Expenditures: The World Bank estimates that tax expenditures (exemptions, concessions, and preferential rates) rose from 1.3% of GDP in FY2016 to 2.7% of GDP in FY2022.^[5] Major categories include petroleum sector exemptions, power generation equipment, and food items.

The Debt Burden

Persistent deficits have accumulated into a substantial debt stock. Public debt including guaranteed obligations reached 72.4% of GDP in June 2024.^[1]

Debt Trajectory

Fiscal Year	Public Debt incl. Guarantees (% GDP)
FY2015	60.0
FY2016	63.2
FY2017	63.8
FY2018	68.2
FY2019	81.2
FY2020	84.0
FY2021	77.6
FY2022	80.6
FY2023	81.6
FY2024	72.4

Source: Ministry of Finance via World Bank PDU October 2024, Annex 3^[1]

The debt ratio peaked at 84.0% of GDP in FY2020, driven by the large deficit and exchange rate depreciation that inflated the rupee value of external debt. The sharp improvement from 81.6% in FY2023 to 72.4% in FY2024 reflects the primary surplus achievement, nominal GDP growth, and rupee appreciation.^[1]

Despite this improvement, the debt ratio remains well above the FRDLA ceiling of 60% of GDP. Pakistan last met this target in FY2015.^[1]

Debt Composition

In FY2024, domestic debt was 44.5% of GDP, external government debt was 24.8% of GDP, and guaranteed debt was 3.2% of GDP.^[1] The relatively high share of domestic debt exposes the government to domestic interest rate movements, while external debt creates currency risk during depreciation episodes.

Who Bears the Burden?

Beyond the macroeconomic numbers, Pakistan's fiscal system has important distributional implications.

The Regressivity Question

The World Bank's Commitment to Equity (CEQ) Assessment found that Pakistan's fiscal system is "uniquely regressive" among assessed countries.^[6] The poorest 10% of the population pays a greater share of their income in taxes than the richest 10%, primarily because indirect taxes (which fall disproportionately on consumption) dominate the tax structure while income from agriculture and property remains largely untaxed.^[6]

This finding challenges the notion that Pakistan's low tax-to-GDP ratio benefits the poor. While the wealthy may avoid income and property taxes, the burden of indirect taxes and inadequate public services falls on lower-income households.